How to Process Payroll in 8 Easy Steps

By Matt D'Angelo, Staff April 9, 2019 07:00 am EST

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Credit: chainarong06/Shutterstock

When it comes to processing payroll, investing in a payroll system or working with an accountant is usually the best choice. There are endless administrative and tax-related responsibilities involved with payroll that can make it a real chore. According to the pitch from major payroll providers, you're better off spending time working on growing your business than processing payroll. Yet, many small businesses process their own payroll.

If you're interested in processing payroll manually and saving a few dollars each month in payroll solution fees, there are a few steps you need to take. Keep in mind that, depending on the size of your business, this can be a very complicated process.

If you're not already an expert in payroll and tax law, you could run into issues with the IRS. While this guide will provide you with some actionable steps, you should consult an accountant or payroll professional to ensure you're compliant with state and federal tax and employment requirements. This guide includes a basic overview and then a more detailed, step-by-step process for manually completing your company's payroll.

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Basic payroll processing steps

View these basic steps as a roadmap for your payroll process. There are a lot of details, so it can be easy to get lost in the minutiae. If you have payroll experience and need a quick refresher, this first set of steps can be a quick resource. If you're looking for a deeper dive, keep scrolling to the full breakdown below. There's also a list of resources at the end of this story, so if you need quick insight on something, you can find those links at the bottom of the page.

How to process payroll

Step 1: Establish your employer identification number

The first step you need to take in processing payroll is determining your employer identification number (EIN), and establishing your state and local tax IDs. These identifications will be used by the government to track your businesses payroll taxes and ensure you're meeting requirements. If you don't know your EIN, or don't have one, you can visit the IRS website to set it up. For your state and local tax IDs, you'll have to go through your state and municipality. [Interested in a payroll system for your small business? Check out our reviews and best picks.]

Step 2: Collect relevant employee tax information

Before you start processing payroll, you'll have to have your employees fill out various tax forms so you can account for allowances and other tax details. These forms include W-4, I-9 (if it is a new employee) and W-2. There are various state and local forms you will have to provide, but these will hinge on where your business is operating. If you have contract-based employees, you'll have to provide 1099s.

Step 3: Choose a payroll schedule

Once you have the relevant tax and legal information to set up payroll, you can choose a schedule that works best for your business. There are four main schedules: monthly, semi-monthly, biweekly and weekly. It's important to understand a full breakdown of each plan before deciding which is best for your business. Once you choose a schedule, set up a calendar with paydays and make note of days where you'll have to process payroll for your workers to get their money on that defined day. Build in important quarterly tax dates, holidays and annual tax filings. Keep in mind you'll have to do this at the start of every year. You'll also want to establish the preferred delivery method of each employee. Many businesses offer both paper checks and direct deposit options, for example.

Step 4: Calculate gross pay

Now that you've set a payroll and work schedule, you can start processing your first payroll. To do this, you must calculate each employee's gross pay. An employee's gross pay is the sum of the number of hours an employee works in a given pay period multiplied by their hourly rate. Start by calculating the number of hours an employee has worked in a given pay period, and take note of overtime hours. The extra time has to be paid out at a higher rate consistent with federal law. If an hourly worker puts in more than 40 hours per week, you'll have to pay time and a half, or an employee's hourly wage plus half that wage.

Here's an example of calculating gross pay.

Worker A has worked 50 hours for your weekly pay period and earns $10 per hour.

40 hours x $10/hour = $400

10 hours x $15/hour (time and a half) = $150

Gross pay = $550

Step 5: Determine each employee's deductions

Gather information from your workers' W-4s, federal and state requirements, insurance requirements, and benefits requirements to determine each employee's deductions. This is where the legwork comes in to processing payroll for your company. Each state is different and takes different taxes from small businesses, so you'll have to research your state's policies before you complete this step. Here's a basic list of some hypothetical requirements:

Federal taxes

Social Security

State taxes

Local taxes

Medicare

401(k) contributions

Workers' compensation contribution

Other benefits

Step 6: Calculate net pay and pay your employees

Take each employee's gross pay and subtract their deductions from this amount. What's leftover is the employee's net pay, or take home pay. This is what you'll have to pay out to each employee via direct deposit or paper check, depending on what your workers prefer and what you can provide. The deductions you'll have to hold and pay with your payroll taxes each month or quarter, depending on the schedule you establish.

Once you've established each employee's net pay, you can pay out your workers on their scheduled payday.

Step 7: Keep payroll records and adjust to mistakes

As you process payroll, it's important to keep records of your transactions for tax and compliance purposes. If an employee disputes payment, or the IRS needs some kind of documentation down the line, you need to have records at the ready. Especially in the case of an employee disputing a paycheck, it's important to maintain records, including year-to-date payment, so you can sort out any issues that arise.

Step 8: Other considerations

Keep in mind that you have to file your business's taxes on a quarterly and annual basis. It's important to consult with an accountant to understand how your payroll taxes fit into this aspect of your operations. It's also important to remember that you'll have to report any new hires you make. Working with a payroll solution or an accountant means that this usually isn't your responsibility.

Resources

Processing payroll manually can be difficult, so these resources can help provide additional support as you start your payroll operations.

Using payroll services

If you partner with an accountant or sign up for payroll software, you won't have to complete any of these steps. In a payroll solution, you'll have to enter relevant employee information and approve hours. The platform will calculate all the deductions, gross pay and net pay automatically. Payroll providers usually have web portals where your workers can log in to view pay stubs, end-of-year tax documents and update their information.

If you work with an accountant, you can set up a system with this person to ensure your business's payroll is being processed properly. Manually processing payroll can be a cumbersome task. Working with a platform can be more convenient for your workers and take the burden off your shoulders. Keep in mind that if you process payroll manually, it will often take multiple days of work to ensure workers get their checks for the right amount on time. With a payroll solution, all you must do is approve hours and click a button.